Sunday, August 22, 2010

When will China pass America?

Much is being made over the fact that China just passed Japan to claim the title of "world's second-biggest economy." Although this has provoked a spate of hand-wringing over Japan's decline (see here and here and here, for example), more level-headed commentators point out that China has eleven times as many people as Japan; for 1.34 billion people to have remained permanently poorer than 1.27 million people would have been (and for a century, was) a human disaster of epic proportions. Sure, Japan has made a lot of mistakes, but those are most certainly not the reason for China's ascendancy.

The next question on everyone's lips, naturally, is: When will China pass the U.S. to become #1? The consensus in the media seems to be that China had better not get too confident; like Japan in the 80s, they argue, China's rapid growth has come at the expense of inefficient overinvestment, misallocation of capital, suppressed consumption, and the entrenchment of special interests that will not be easily dislodged when the boom finally runs its course.

And I agree: China does share many of Japan's weaknesses. Some of these, fact, seem far more severe in China than they did in Japan - the corruption, the pollution, the suppression of consumption, the state control of banks. These are the kind of things that raise a country's growth during the "extensive" phase, when all you have to do to grow is save, save, save, and invest, invest, and invest. But because the same people who received the cheap capital during the boom will continue to hold the strings of the state after the economy gets saturated with buildings and roads and machines, this growth model bakes inefficiencies into the economy. Growth goes faster, but crashes more abruptly and at a lower level.

That said, the sheer numbers involve make it HIGHLY unlikely that China will NOT overtake America in the near future. If China were twice as big as the U.S., I'd say there was some chance they'd never be richer than us. But they are 4.3 times as big.

To see how certain a thing this is, let's do some rough calculations in our heads. This is pretty easy, with the Rule of 70; to find out how fast something doubles, divide 70 by its percentage growth rate. Thus, if China is growing at 10% and America at 2%, China's economy will double in size relative to America's in 70/8 = 8.75 years.

Now, let's do some math. Japan's growth slowed when it hit about half of U.S. per capita GDP (in the late 70s). Same for South Korea in the late 90s. Assume for the moment that China's slows at around the same level. China's GDP per capita is now about 16% o...r 17% of America's. At a relative growth rate of 8% (the average for recent years), China will hit half of America's per capita GDP (and more than twice America's total GDP) in a little more than 15 years.

But perhaps China has more limitations than Japan and South Korea did; suppose that corruption, resource constraints, or China's size relative to its trading partners acts as a check on its growth. Suppose for this reason, China's growth slows when it hits 35% of America's per capita GDP (and 1.5 times America's total GDP). That's still 10 years of hyper-charged growth.

Now suppose that China's growth slows a little bit, so that the growth rate relative to the U.S. is only 6% (i.e. about how fast India is growing now). And assume China reaches only 35% of America's per-capita GDP before its growth slows even more. That's 14 more years of pretty fast growth!

Put this another way: for China to fail to overtake U.S. total GDP, they will have to stall out at 23% of U.S. per capita GDP - the average Chinese worker will have to less productive than an entry-level employee at Wal-Mart. This would mean that their growth would have to stall within 5 years (if we measure GDP in PPP terms, or if they allow their currency to appreciate) or 7 years (if we measure GDP in nominal terms, and they keep their currency undervalued forever and ever).

So, basically, unless China's growth crashes spectacularly and semi-permanently by the midpoint of this decade, their economy will be larger than that of the U.S. by the mid-2020s. That would be an unprecedented slowdown, MUCH more severe than what Japan experienced in the 90s, and at a far lower level of development. I doubt any reasonable China critic would predict such a Biblical disaster.

Thus, the inescapable answer is: China will soon be the world's largest economy, no matter how you measure things. This will happen in less than two decades. And GDP is a direct measure of national power. We must therefore prepare for a world in which the leading geopolitical hegemon will be a non-democratic country, a country with little stake in the existing system of international norms and institutions, a country with hundreds of millions of citizens still living in poverty.

How much of the world we knew in the 20th Century was dependent on the hegemony of free-trading democratic countries? How much of the seemingly unstoppable technological progress, the respect for international boundaries, the slow advance of human rights, etc. were dependent on the lucky fact that the U.S.-Britain-France alliance (and later, the U.S.-Britain-France-Japan alliance) had the most guns?